Question

# Suppose the U.S. yield curve is flat at 5% and the euro yield curve is flat...

Suppose the U.S. yield curve is flat at 5% and the euro yield curve is flat at 4%. The current exchange rate is \$1.25 per euro. What will be the swap rate on an agreement to exchange currency over a 3-year period? The swap will call for the exchange of 1.2 million euros for a given number of dollars in each year. (Do not round intermediate calculations. Enter your answer in millions rounded to 4 decimal places.)

Swap Rate _____ million per year?

The forward price can be determined as follows

Forward exchange rate * \$1.2million euro =dollars’ delivered.

While forward exchange rate = current exchange rate * (1+ U.S yield curve)/(1+ euros yield curve)

Year 1: 1.25 *(1.05/1.04) * 1.2 million euros = 1.5144 million

Year 2: 1.25 *(1.05/1.04)^2* 1.2million euros =1.5290 million

Year 3 : 1.25 *(1.05/1.04)^3* 1.2million euros =1.5437 million

The number of dollars each year is determined by computing the present value.

1.5144/1.05 + 1.5290/1.05^2+ 1.5437/1.05^3 = 1.4423 +1.3868 + 1.3335 = 4.1626

So, Swap rate = 4.1626/3 = 1.3875 million per year